The good, the bad … and the ugly prospects of a fiscal cliff

WEST MICHIGAN — The housing market is getting back on its feet, consumer spending is up and the auto industry should remain in good shape. That’s the good news about the economy.

The bad news: sluggish job growth, Europe’s recession that will affect the U.S. economy, and the impending “fiscal cliff” — the combination of more than $600 billion in automatic federal spending cuts and tax increases that kick in Jan. 1 unless Congress acts.

Economists generally see an impact on the U.S. economy from the fiscal cliff, although they differ on how much.

Mitch Stapley, chief investment officer for Fifth Third Asset Management, believes the effects could generate a short, shallow recession in early 2013. It would become, Stapley said, “one of the most needless recessions in American history,” caused by political polarization in Washington, D.C., that has left Congress and the president unable to resolve the issue for months.

“It’s as if this suddenly has popped up,” Stapley said. “This is a self-inflicted wound. We took the gun out, we put the bullets in it, and we shot ourselves in the foot.”

Some scenarios have the effects on the U.S. economy from the federal spending cuts and tax increases — the latter stemming from the expiration of tax cuts enacted under former President George W. Bush — going as far as trimming 3.5 percentage points off GDP, Stapley said.

Even if Congress does act and heads off part of the fiscal cliff, the economic effects could still trim 1.5 percentage points off GDP — “if we’re lucky,” Stapley said.

For now, Stapley sees the U.S. economy falling into a shallow recession for a brief period in the first quarter and recording just a 0.5-percent GDP gain for the first half of the year, then recovering in the latter half for an annual rate of 2.5 percent.

Comerica Inc. Chief Economist Robert Dye expects Congress to act during the first quarter to ease the economic impact of the tax increases and spending cuts, but he believes the fiscal cliff’s impact could go higher and take as much as 4.0 percentage points out of the GDP if fully implemented. Dye anticipates action that would result in a 1.5- to 2.0-perentage-point hit to GDP.

“Right now the economy is in the hands of Congress and we’ll have to wait and see what they do,” said Dye, citing the difficulty in projecting the future economy amid the uncertainty of what Congress may do about the fiscal cliff.

“Right now, it’s an entirely political forecast, not a macro-economic forecast,” he said.

Dye doesn’t expect to see a recession next year, and overall projects 2.3 percent real GDP gains for the full year in 2013. He sees slower economic growth early in the year.

Stone forecasts real GDP growth of 2 percent to 2.5 percent for the year with weaker growth in the first six months of the year and stronger growth in the second half.

“We’re definitely tilted toward continued recovery and expansion. It’s just a relatively tame expansion in the economy,” Stone said.

On the fiscal cliff, Stone also believes that both Republicans and Democrats in Washington will compromise and that Congress, either in the lame-duck session or in early 2013, will act to mitigate the impact and extend some of the Bush-era tax cuts.

“I think something happens there in the middle,” Stone said.

University of Michigan economists, in their most recent forecast issued in mid-September, predicted real GDP growth of 2.1 percent for 2013, with gains steadily accelerating during the year to 2.4 percent by the fourth quarter, followed by 2.7 percent GDP growth in 2014.

The outlook is predicated on expectations that “most of the tax provisions will be renewed for a year to give the new Congress and administration time to negotiate a compromise. Our forecast assumes some spending restraint over the next two years, the end of the payroll tax cut — as scheduled — in 2013, and a modest income tax increase in 2014 as a first step toward deficit reduction,” economists at the U-M’s Research Seminar for Quantitative Economics wrote in the outlook.

One positive note for Michigan is a continuation of the auto industry’s strength.

U-M economists project North American light vehicle sales to grow to 14.9 million units in 2013, up from an estimated 14.3 million in 2012. Stapley at Fifth Third sees sales of 14.5 million to 15.0 million units in North America in 2013, and PNC’s Stone projects 14.5 million units.

J.D. Power and Associates said in late October that it expects North American light vehicle sales to hit 14.4 million units for this year and grow to 15.0 million units in 2013. North American production could approach 16.0 million units for the first time in more than a decade, the company said.

Playing into the industry’s favor is an improved debt-to-income ratio that coincides with a high average age of vehicles now on the road, which creates a pent-up demand, Stone said. Coming out of the recession, consumers have been paying down their personal debt, he said.

“If they want to go out and get a car, they’re in a good spot to be able to do so,” Stone said.